Price hikes offset rand strength
May 15, 2009
By Ethel Hazelhurst
Central bank sees strong currency improving inflation outlook
Wages and regulated tariffs are threats
The recent strength in the rand has improved the inflation outlook, according to the Monetary Policy Review released yesterday by the Reserve Bank. However, increases in administered prices and big wage rises threaten these prospects.
Administered prices apply to petrol, diesel and paraffin, as well as the services of public utilities, local governments and educational institutions.
The review, published twice a year, says sustained improvement in the rand would reduce "the upside risk to the inflation outlook". A stronger currency reduces the prices of imported goods in rand terms.
However, the risk to inflation posed by a weak currency has been replaced by threats from administered prices, including higher-than-expected electricity tariff increases.
The review notes that the rand has appreciated by 31 percent against a basket of 13 currencies since last October. That month, non-residents sold a net R50 billion worth of local bonds and shares, more than double the net sales in any other month last year.
The rand was bid at R8.55 to the dollar and R11.6357 to the euro at 5pm yesterday. On October 27 last year, the dollar was worth R11.31 and the euro bought R14.04.
The bank cited wage inflation as cause for concern: it accelerated sharply to 13.7 percent in the third quarter of last year from 7.1 percent in the third quarter of 2007.
In the first quarter of this year, the average hike in wage settlements was 10.2 percent, ranging from 7 percent in the metal and related manufacturing sector to 12.3 percent in the food-agricultural sector.
The bank expects the second-round effects of administered price rises and wage hikes to keep consumer inflation above the ceiling of its 3 percent to 6 percent target range on a quarterly basis this year.
The review forecasts that inflation, which was above 8 percent in the fourth quarter of last year, will fall to 6.2 percent in the third quarter of this year and rise to 6.4 percent in the first quarter of next year, "before resuming its downward trajectory to 5.4 percent" in the last quarter of 2010.
But the bank warned that recent forecasts were "subject to higher risks than is usually the case" because of "the rate of change in global developments".
It pointed to risks of deflation - falling prices - in some advanced economies. A collapse in investor and consumer confidence globally towards the end of last year sent these economies into recession and sharply reduced growth in emerging economies, dramatically changing the inflation environment.
The review says upside risks to inflation are countered by "the possibilities of a deeper and more prolonged global slowdown. or a more significant moderation in domestic growth".
The balance of risks to inflation has "changed significantly", according to the bank, because of lower food and oil prices and the widening output gap - the spare capacity in the domestic economy that will allow factories to produce more without new investment.
The review says recent indicators suggest the economy will "remain under pressure for some time". It highlights the manufacturing sector as particularly vulnerable.
"On the (manufacturing) supply side, production volumes have declined sharply due to declining sales volumes and high levels of finished good inventories." On the demand side, it says manufacturers have reported declines in both domestic and export orders.
As growth has slowed and inflation expectations have improved, the central bank has cut its official repo rate from 12 percent last December to 8.5 percent now. Economists expect more cuts - possibly to as low as 6 percent.
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